Explain Like I'm Five (ELI5): Bitcoin

What Bitcoin is and why it matters in (relatively) plain English.

I'm a self-confessed technology nerd. That doesn't make me much of a hit at parties, where I'll tend to talk incessantly at anyone who'll listen about my love of digital technology, but it does occasionally have its advantages. Or so my (very small number of) non-tech friends tell me anyway.

That's because about once every 5 to 10 years or so, I tell them about some new innovation that I think they really need to pay attention to. Something I’m sure is going to be a game changer. I think they reckon it’s worth putting up with the ear-chewing they get the rest of the time because those insights occasionally give them a useful head start on their peers and colleagues.

So far I’ve introduced them to four digital innovations that went on to change our world, at a time when relatively few others had appreciated how much of an impact they were going to have. The first of these was email in 1990.

I told them about using email to contact all sorts of exotic people around the world I’d never have been able to get in touch with any other way. But they weren’t particularly interested because the only person they knew with an email address was me, and they already communicated with me more than they perhaps wanted to.

The second innovation I introduced them to was the World Wide Web around 1996. I convinced them they had to get connected and plug themselves into the world’s new information superhighway where they could learn about anything.

But unfortunately they didn’t have the same love of Star Trek and Monty Python that I did, because that’s pretty much all there was on the web back then. So it was a bit underwhelming for them to be honest; but at least they were connected early and knew all about it by the time everyone else cottoned on to how useful it could be.

The third was smartphones around 2002 – the idea I could take my email and web access with me wherever I went was revolutionary to me, as was the ability to find addresses of meeting locations in unfamiliar cities, or take photos of interesting things and send them to colleagues and family via email.

As before, my friends weren't that impressed as they didn’t have a use for it, and they stuck to their trusty old phones way longer than I would have believed because battery life for calls mattered more to them than features. Eventually however, even they - like everyone - succumbed to the lure of having a digital Swiss Army Knife in their pockets.

Fourth was social media in 2008. My friends are generally as shy and anti-social as myself, so they all hated the idea of social media; as introverts, we’d have much preferred someone inventing anti-social media, but despite my own misgivings I could see it was changing how conversations were happening online and shifting the power dynamic between established journalists and citizen journalists.

I’d reluctantly got on board and was sure they needed to be using it so they could understand its impact by the time it finally became mainstream.

And so it was, with four out of four technology predictions having been borne out by events over the intervening years, that my technology-nerd credentials were riding high in June 2017 when I got in touch about a potential 5th World Changing Technology my firends needed to swot up on.

This time the technology I was raving about was Bitcoin. I'd seen it announced in 2009, dismissed it as 'just another e-gold', and then finally started playing around with it in 2014. Three years and hundreds of hours of research later I was sure this wasn't just another e-gold, this was 'the real thing' - a native, peer-to-peer payment layer for the internet without the need for any trusted intermediary, such as a bank.

My opinion slowly and reluctantly changed from skeptic to advocate as I did ever more research and still failed to find the critical design flaw I was sure must be there.

But no, I eventually had to admit this was another genuine game changer, at least as important to the evolution of the Internet as the invention of the World Wide Web had been. But despite my reputation riding atop four prize technology predictions, and a conviction built on years of personal study, my friends still wouldn’t take my word for it that these “Magic Internet Beans” were anything more than a scam.

They insisted I explain two things to them:

1. What on earth is bitcoin? and

2. Why on earth should they care about it?

Two excellent questions, but two questions my research hasn’t found easy, 'human readable' answers to. All the best explanations of Bitcoin I've seen to date, still require a lot of additional legwork to understand the importance of unfamiliar concepts such as 'Austrian Economics', 'Cryptographic Hashing', 'Byzantine Generals Problem', 'Double Spends', 'Proof-of-Work', and other uber-nerdy concepts, each worthy of considerable study by themselves.

What I was looking for was a light-touch explanation that conveyed the basics of Bitcoin, along with its potential importance for the world, but without referring to any concepts that would be unfamiliar to an intelligent, but non-technical reader.

Long story short, I couldn't find one, so I wrote it instead.

Here then, I’d like to share with everyone the best answers I came up with to my friends’ questions to help them understand what Bitcoin is, and what it isn’t.

What On Earth Is Bitcoin?

Bitcoin is just a network, so in many respects you can think of it in exactly the same way as any other network; whether that's the World Wide Web network, the email network, the telephone network, or indeed the postal network.

Specifically it’s a computer program that defines standard rules everyone must accept before they can use the network. That means so long as someone sticks to using those rules they can interact with anyone else on the bitcoin network. And if they don't? Well, they can't; end of story.

What do I mean by a set of rules? Start by thinking of the postal network which everyone's already familiar with. We are all users on the postal network, and to pass anything to another member of the postal network we must:

1. Know the name of the recipient;

2. Know the address of the recipient;

3. Wrap the item we want passed to the recipient in accordance with the network's standards;

4. Label the item clearly with all the information the network requires to process it;

5. Take it to an authorised collection point;

6. And additionally we must also prepay the corresponding fee for using the network;

If we stick to those rules then we are able to utilise the postal network; if we don't, then we can't. Simple.

That's an example of a very analogue network that we're all familiar with, where the network rules rely on an actual person doing something specific at each stage to make it work. What about a digital network then?

A digital network just replaces the people who have to handle whatever we're sending manually, with switches that handle it automatically to speed things up. Today the telephone network is a great example of a fully digital network. Though if anyone's interested in how networks evolve then it's a great example of that too, because it originally started out as analogue as the postal network and then sequentially became mechanical, electro-mechanical, electronic, and finally digital.

What are the rules of the telephone network then? Again, to connect with another member of the telephone network we must:

1. Know the unique identification number of the member we want to speak with (non-nerds just call those telephone numbers);

2. And input that identification number in the specific format the network expects (that is <international code>, <area code>, <user code>)

3. And, again, we must also prepay the corresponding fee for using the network;

If we follow those rules the network will connect us to the user we want to speak with; if we don’t, our call gets rejected. Again, all simple enough.

So these are examples of two networks we're familiar with that require us to follow a set of standard rules if we want to use them.

Bitcoin works in a similar way to these networks, except that it doesn't allow users to transfer physical items as the postal network does, or speech as the telephone network does. Instead, its only function is to keep track of unique digital tokens, and to let network users store and send them to each other whenever they want. Each of those unique digital tokens is a “Bitcoin", and again, you can think of these just as a bank might think of its own individual tokens with unique serial numbers as "pound notes", “euro notes”, or "dollar bills". This ability to store and track unique tokens as they move between users is what gives bitcoin the characteristics of a monetary network.

However, pounds, euros, and dollars require banks with all their complex governance, physical branches, staff, security guards, etc. to track those unique tokens as they move between user's bank accounts. Bitcoin, on the other hand, does all of this without a bank, its staff, or any of the administrative overheads, because the process for issuing the tokens, auditing the transactions, and recording the balances of each individual user is built right into the network rules themselves. By simply using the network all of that administrative overhead is taken care of automatically by the network itself.

So what on Earth is bitcoin then?

Bitcoin is an autonomous, digital network that allows its users to store, send, and receive unique digital tokens, and those unique digital tokens are known as Bitcoins. That’s it in a nutshell.

Why Does Bitcoin Matter?

So if that's all Bitcoin really is, why do people like me think it's such a big deal?

It's because of these three key characteristics of the network:

1.  It is fully digital

2.  It is fully permissionless

3.  It is fully decentralised

Let's look at each of those in turn.

Fully Digital

Bitcoin functions as a fully digital monetary network, as compared with a partially digital monetary network like our current banking network. This means that Bitcoin has the potential to provide the same core functionality as banks without the need for physical banks, in just the same way as the World Wide Web provided the same core functionality as libraries without the need for physical libraries. With all the same convenience, cost, and efficiency improvements that implies.

Semi-digital banks will find it difficult to compete with a fully digital monetary network using current business models. So in the same way as the World Wide Web superseded the world's information repositories and archives, Bitcoin has begun superseding the world's banking and financial institutions. That might seem a ridiculous claim today, but then I’m old enough to remember when people thought it equally ridiculous that Google and Wikipedia might one day supersede the Encyclopaedia Britannica. The invention of Bitcoin has many parallels in my opinion, and I, for one, expect the resultant disruption it causes to be equally profound.

In that regard bitcoin is just like the World Wide Web: a new type of digital network that operates across the Internet, this time with the potential to disrupt the world’s financial sector rather than the world’s media sector. Most importantly, this disruption does not apply only to companies that operate in the business of finance either; it also applies to the foundational cornerstone of the financial market: money. 

We in the UK and other developed nations are at a disadvantage when it comes to appreciating why this matters so much. After all, we enjoy the convenience of living in countries with relatively stable currencies, being able to store our money safely in reasonably reliable banks, and send our money to anywhere in the world whenever we want for reasonable rates. But that's because we are incredibly lucky to live in one of the world’s wealthiest countries.

We live in a G7 economy with one of the world's most advanced banking sectors, and we take it for granted that our standard bank accounts give us the ability to send money to anyone we want, wherever we want, whenever we want, at little or no cost.

That's not the case for everyone everywhere though. According to World Bank data, there are almost 2 billion people around the world today without any access to basic banking services. Mostly in developing nations, in Asia, Africa, Central and South America. There are many complex reasons for this, but often it is due to political instability or people living in extremely rural areas where it is simply not economically possible to provide banking facilities, even when there is political stability. Bitcoin is a global network, accessible by anyone with a basic smartphone, which means that a person plugging into the network from rural Malawi has access to exactly the same quality of service as a person plugging into it from central London.

To put that in context, according to the World Bank only 40% of people in Malawi have a bank account, while more than 50% have access to a mobile phone. But Bitcoin isn't just an opportunity to bank the unbanked here and in developing countries; it’s also a leveller. It’s an opportunity to let the people bypass the vagaries of their local banking systems and plug directly into a global, 1st world banking system, removing much inequality with savings or spending technology enjoyed by those living in first world nations.

So those are examples of some effects a fully digital monetary network provides. What about the next characteristic: permissionless?

Fully Permissionless

Providing we follow the network rules, bitcoin doesn't care who we are, where we are, or what we believe.

It doesn't care whether our partner, parents, employer, government or anyone else approves of us having a bank account or not. It doesn't care whether anyone approves of us sending payments to our family members that live across borders in different countries. And it doesn't care whether anyone approves of someone sending payments to us either. It processes the transaction completely neutrally, without fear or favour, regardless of who we are or where we are.

This can make a material difference in poorer economies, such as right now in El Salvador. El Salvador ranks 103rd in the world in terms of total GDP and its GDP per person is only $4,031, approximately a 10th of what we enjoy in the UK. Many families rely on money transfers from relatives who travel abroad to find work in order to support their families. That enables people who would normally be beholden to money transfer companies such as Western Union to bypass the fees these companies charge, which can be as much as $25 per transaction.

That may not sound much to ourselves who might be expecting to send thousands of dollars, but the people making these transfers in countries like El Salvador are rarely sending thousands of dollars at a time; more typically they are relying on a family member sending them $50, or $100 each week, and that $25 processing fee can end up eating a quarter to half of their earnings.

That's the equivalent of more than three hours of labour at the Federal minimum wage in the US ($7.25/hr) - meaning some must work half-a-day each week just to pay the transfer fees that let them send money back to feed their families.

Fully Decentralised

Lastly, and perhaps most importantly given the other characteristics I've described, is that Bitcoin is decentralised, which means that just like the Internet and World Wide Web themselves, there is no single point of failure that can be targeted to shut bitcoin down. Given the resources that incumbent financial companies and governments have at their disposal that's important, because just taking El Salvador as an example, it’s expected that the government's decision to promote bitcoin usage in the country could cost remittance companies as much as $400M in revenue per year.

And while that might be over-estimateing the problem for political effect, it’s just one country in one year. Extrapolating even a fraction of that amount across the entire globe makes it easy to see those kind of losses create a lot of incentive for a lot of people with a lot to lose to shut Bitcoin down for good. Disruption is not desirable for existing market incumbents, and they will do everything they can to maintain their position and competitive advantage.

If bitcoin were a normal 'company' such as a PayPal or a Visa, then it would be relatively easy for incumbents to find the CEO and come to an arrangement that was too good to refuse in order to keep fees at a level that would preserve the profitability of the current system. But in a decentralised system, run entirely by computer software, there is no one for a company or a government to lobby into stopping the service when their own business profits are being undermined by it.

Over the years we've seen Visa, MasterCard, PayPal, etc. all pressured by governments into cutting off services to individuals, companies, or entire countries for various political reasons by putting pressure on the directors or shareholders of these companies. With bitcoin there is no CEO to call, no shareholders to appeal to, no advertisers to boycott; just a set of dispassionate rules that mean your transfer gets processed providing you stick to them. Which makes it impossible to shut down without shutting down the Internet itself. That's incredibly hard to organise in practice, rendering it essentially unstoppable at this point, just like the World Wide Web, and so the growth of the Bitcoin network into a new global financial standard seems as inevitable to me as the spread of the Web was 25 years ago, as more people begin to appreciate the benefits of transferring money with anyone, anywhere, without the need for any intermediary.

That means global, 1st world digital banking services and property rights will be available to everyone, anywhere on the planet, regardless of their personal circumstances, and independent of the limitations imposed by their own local systems - all they need to access it is a mobile phone or a laptop with an Internet connection. In short, it changes the rules of global finance for the first time in over 70 years, in ways that parallel what the World Wide Web did to our media industries 20 years ago.

In Summary

That’s why I consider it important for people to be aware of Bitcoin today, and to keep an eye on how it develops. Just as with the rise of social media, regardless of whether we like these changes or believe they will be good or bad for society, it’s going to be hard to ignore them - so best to be aware of them.

Email disrupted how we communicate; the Web disrupted how we access information, social media disrupted how we form our opinions, and now Bitcoin is disrupting how we store and transfer our wealth. It's already become a lifeline for many in developing nations, but even developed nations like our own will likely feel the impact eventually.

Which is why I'd recommend to anyone interested in finding out what the future of banking might look like; don’t take anyone’s word for it. Start studying Bitcoin in more detail for yourself and decide for yourself.

Hopefully this “ELI5” introduction to the topic can help demystify the topic sufficiently to get you started.

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